In a previous article, I discussed the related person definition for the purposes of the Internal Revenue Code (“IRC”) §267. That article, however, focused on the definition itself rather than on a host of supplementary rules necessary to fully understand this definition. In this article, I would like to discuss one set of these rules – §267 constructive ownership rules.
§267 Constructive Ownership Rules: Purpose of §267(c)
During my initial discussion of the §267 related person definition, I focused only on the actual ownership by related persons. Congress, however, realized that the actual ownership limitations can be easily circumvented by utilizing individuals and entities closely connected to the related persons.
Hence, it enacted §267(c) and §267(e)(3) to expand the application of the related person definition to include the ownership by closely-connected individuals and entities. In other words, even where an individual or entity does not meet any of the §267(a) and (b) tests through his actual ownership, these tests may be met when his actual ownership is added to other persons’ ownership through the operation of §267(c) and §267(e) rules. These are the so-called §267 constructive ownership rules.
§267 Constructive Ownership Rules: Two Parts of the Rules
As explained in a previous article, the related person definition can be found in two different parts of §267 – thirteen categories of §267(b) and one category of §267(a)(2). Similarly, the constructive ownership rules are divided into two separate sections: §267(c) applies to the entire section and §267(e)(3) applies only to §267(a)(2).
§267 Constructive Ownership Rules: Three General Types of Ownership Attribution
§267(c) sets forth three general types of constructive ownership attribution rules:
- Entity-to-owner or beneficiary stock attribution – i.e. “stock owned, directly or indirectly, by or for a corporation, partnership, estate, or trust shall be considered as being owned proportionately by or for its shareholders, partners, or beneficiaries” §267(c)(1). I wish to emphasize there that §267(c)(1) applies to any type of an entity: corporations, partnerships, estates and trusts;
- Family member stock attribution – i.e. stocks owned by family members are treated as constructively owned by the related person (see §267(c)(2)). §267(c)(4) defines “family of an individual” to include: “only his brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendants”; and
- Partner-to-partner stock attribution – i.e. “an individual owning … any stock in a corporation shall be considered as owning the stock owned, directly or indirectly, by or for his partner” §267(c)(3). This is a unique rule which is rarely found among other constructive ownership rules of the Internal Revenue Code.
§267 Constructive Ownership Rules: Chain Ownership Attribution
Generally, a taxpayer who is deemed to own stock under the §267 constructive ownership rules is treated as the actual owner of the stock. In other words, the stock that he constructively owns can be used for further attribution of ownership to others – this is the so-called “chain ownership attribution”.
There are three exceptions to this rule. I will mention here only one: §267(c)(5) limits attribution of ownership through a chain of related persons in the case of family member or partnership attribution.
§267 Constructive Ownership Rules: Fourth Type of Ownership Attribution
§267(e)(3) sets forth special constructive ownership rules for determining ownership of a capital or profits interest in a partnership; as it was mentioned above, this rule applies only to the deduction limitation rules of §267(a)(2). This fourth type of ownership attribution is basically an exception to the first three types of §267(c).
§267(e)(3) states that, for the purposes of determining ownership of a capital interest or profits interest of a partnership, §267(c) constructive ownership rules apply except that: (1) partner-to-partner stock attribution of §267(c)(3) shall not apply, and (2) with respect to interest owned (directly and indirectly) by and for C-corporation “shall be considered as owned by or for any shareholder only if such shareholder owns (directly or indirectly) 5 percent or more in value of the stock of such corporation” §267(e)(3)(B).
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